Fitch Affirms Baystate Medical Center, MA's Revenue Bonds at 'A+'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the 'A+' rating on the following bonds issued by the Massachusetts Development Finance Agency on behalf of Baystate Medical Center (Baystate):

--$55,115,000 revenue bonds, series N (2014).

In addition, Fitch affirms the 'A+' rating on Baystate's outstanding debt issued by the Massachusetts Health and Educational Facilities Authority, which is listed at the end of the press release.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by the obligated group's gross receipts.

KEY RATING DRIVERS

LEADING MARKET POSITION AND INTEGRATED SERVICE NETWORK: Baystate's integrated delivery network includes four hospitals, employed medical groups, a health plan and a physician hospital organization. The integrated healthcare network bolsters Baystate's market profile in an evolving environment that is accelerating towards value-based care and population health management. As for Baystate's inpatient hospital market position, they secure a leading 56% share in a large three county primary service area, well more than twice the level of its nearest competitor.

LOW DEBT BURDEN: Baystate's maximum annual debt service (MADS) of approximately $33.37 million (excluding an $11.6 million balloon payment in 2026) amounts to a low 1.4% of revenues through nine months of the current fiscal year (year-end Sept. 30). As a result, despite the softer earnings and cash flow, MADS debt service coverage is very good at 4.9x for the unaudited nine month period ending June 30, 2016. Furthermore, MADS is projected to decline by about $4.7 million in fiscal 2017 since Baystate's new markets tax credit deal is expected to unwind and result in the forgiveness of debt.

WEAKER OPERATING PERFORMANCE: After stable operations from fiscal 2012-2014, profitability weakened during the past few years due to losses at a newly acquired hospital and employed medical groups, increased staffing and pharmacy costs at Baystate's hospitals, as well as operating challenges arising from expanded Medicaid enrollment at its health plan, Health New England. After falling to negative 0.5% and 3.3%, respectively in fiscal 2015, the operating and operating EBITDA margins improved to 1.8% and 5.4% (prior to one-time reduction in force costs), respectively during the first nine months of fiscal 2016.

SOFTENED LIQUIDITY METRICS: As of June 30, 2016, $803.6 million of cash and investments amounts to 131.1 days cash on hand (DCOH) and 139.7% of long-term debt, down from 175.4 DCOH and 171.4% cash to debt at the end of fiscal 2014. While the absolute liquidity levels have remained relatively stable, growth in the business base from acquisitions and health plan enrollment gains, as well as increased long-term debt are suppressing liquidity ratios.

RATING SENSITIVITIES

OPERATING PERFORMANCE: While financial performance rebounded somewhat in the current fiscal year, operating challenges persist due to governmental payment reductions and expense pressures at both Baystate Health's delivery network and insurance operations. Fitch expects Baystate Health to make the necessary adjustments to maintain the improved performance nevertheless failure to meet budgeted operating targets may result in negative rating pressure.

LIQUIDITY STABILIZATION: Given Baystate Health's low debt burden and good debt service coverage, its cash position is satisfactory for the rating. However, any further softening of liquidity metrics could pressure the rating.

CREDIT PROFILE

Baystate Health, Inc. is an integrated health care delivery system headquartered in Springfield, MA. Baystate Health, Inc. consists of four hospitals (including the 710-bed flagship, Baystate Medical Center), Baystate Medical Practices (a multi-specialty academic group practice with over 550 employed physicians), Health New England (a not-for-profit health maintenance organization with about 223,000 covered lives), a physician hospital organization and other ancillary health care entities. The obligated group only includes Baystate Medical Center and Baystate Total Home Care. Baystate Total Home Care holds a ground lease and real estate for Baystate Medical Center. On a consolidated basis, total revenues in fiscal 2015 (Sept. 30 year-end) were approximately $2.1 billion. The obligated group represents about 65% of total system assets and 53% of total system revenues. Fitch's analysis and the figures cited in this press release include the consolidated entity, Baystate Health, Inc.

BUSINESS POSITION

Baystate's integrated delivery network has driven a successful regional expansion and a leading inpatient hospital market share in a large three county primary service area in west central Massachusetts. Complementing its multiple hospital locations, Baystate employs 550 physicians at more than 60 sites in and around Springfield, MA. Moreover, Baystate's ownership of Health New England rounds out its fully integrated network and provides them control of insurance premiums and enhanced population health capabilities.

While modest service area competition is evident, Baystate's ownership of the region's only academic tertiary hospital and Level I trauma center helps to stem outmigration and maintain a very good market position. The acquisition of Wing Hospital in 2014 and Noble Hospital in 2015 further solidified Baystate's market position in west central Massachusetts. On a combined basis, Baystate secured 56% inpatient market share (as of 2014, which is the most current data available). The next closest competitor was Mercy Medical Center (part of Trinity Health, rated 'AA-'/Negative Outlook), which held less than 20% inpatient market share.

OPERATING PERFORMANCE

After stable operations from fiscal 2012-2014, profitability weakened during the past few years due to losses at a newly acquired hospital and employed medical groups, rising staffing and pharmacy costs at Baystate's hospitals, as well operating challenges arising from expanded Medicaid enrollment from its health plan, Health New England. Specifically, Baystate Wing Hospital that was acquired in 2014 lost $5.1 million in fiscal 2015 and Baystate Medical Practices' losses increased by nearly $10 million in fiscal 2015. At the flagship Baystate Medical Center in fiscal 2015, operating earnings declined by about $17.5 million despite increased volumes as a result of a weaker payor mix and higher labor and pharmacy costs.

Health New England posed the greatest financial pressures during fiscal 2015 due to rapidly expanded Medicaid enrollment, which was subsequently reduced in the current fiscal year. As a result of the Commonwealth of Massachusetts' program expansion and a competing health plan's regional strategy, about 60,000 Medicaid enrollees switched to Health New England in fiscal 2015. Certain of these new enrollees were very high healthcare utilizers with chronic conditions. Therefore, these much higher costs caused Health New England's net income to dramatically decline to negative $28.2 million in fiscal 2015, from a gain of $3.9 million the prior fiscal year. Regardless, management quickly reacted and made the appropriate adjustments in the current fiscal year by dis-enrolling about 13,000 Medicaid enrollees, increasing premiums and renegotiating its pharmacy contract. As a result, Baystate's insurance operations produced a $3.76 million gain through the first nine months of fiscal 2016.

From a metric standpoint, after falling to negative 0.5% and 3.3%, respectively in fiscal 2015 (both metrics exclude a $69.65 million gain on pension curtailment), the operating and operating EBITDA margins improved to 1.8% and 5.4% (prior to one-time reduction in force costs), respectively during the first nine months of fiscal 2016. Management expects financial pressures to persist in fiscal 2017, mostly due to lower health plan rate increases, Medicaid rate reductions and the loss of the rural wage index classification from Medicare. As a result, Baystate closed its Mary Lane Hospital for inpatient services and consolidated its operations with Wing Hospital during September 2016, as well as instituted a reduction in force that is expected to decrease full-time equivalent employees by about 250 to 300 over the next several months. These cost reduction measures are expected to produce fiscal 2017 operating margins that are consistent with current year performance.

LIQUIDITY AND DEBT POSITION

Absolute liquidity levels have remained relatively stable, but growth in the business base from acquisitions and health plan enrollment gains, as well as increased long-term debt are suppressing liquidity ratios. As of June 30, 2016, $803.6 million of cash and investments amounts to 131.1 DCOH and 139.7% of long-term debt, down from 175.4 days operating expenses and 171.4% cash to debt at the end of fiscal 2014. Given Baystate Health's low debt burden and good debt service coverage, its cash position is satisfactory for the rating. However, any further softening of liquidity metrics could lead to rating pressure.

Baystate's total long-term debt (including current portion) increased to $575 million as of June 30, 2016, from $478 million at the end of fiscal 2014. Regardless, MADS of approximately $33.37 million (excluding an $11.6 million balloon payment in 2026) amounts to a low 1.4% of revenues for the nine month period ending June 30, 2016. Additionally, total long-term debt and MADS are most likely to decline by about $81 million and $4.7 million, respectively in fiscal 2017 since Baystate's new markets tax credit deal is expected to unwind and result in the forgiveness of debt.

Given the rising costs of running its pension, Baystate froze its defined benefit plan effective Dec. 31, 2015. The freeze was accounted for as a curtailment and resulted in a one-time credit to the net periodic pension cost of about $71.9 million. In addition, a curtailment gain of $47.9 million reduced the pension obligation and was recorded as an increase in unrestricted net assets. Nonetheless, the pension liability increased to $117 million in fiscal 2015 (for a manageable 88% funded status) from $99.5 million in fiscal 2014 since the fair value of the pension assets declined. Fitch views the pension freeze favorably since it provides expense savings, caps its long-term liabilities, and reduces variability in its financial position.

Outstanding Baystate debt issued by the Massachusetts Health and Educational Facilities Authority rated by Fitch as of Oct. 12, 2016:

--$43,345,000 revenue bonds, series G (2005)*;

--$5,487,000 revenue bonds, series M-4A (2005)*;

--$4,222,000 revenue bonds, series H (2007);

--$6,519,000 revenue bonds, series M-2 (2008)*;

--$63,380,000 revenue bonds, series I (2009);

--$45,000,000 revenue bonds, series J-1 (2009)*;

--$45,000,000 revenue bonds, series J-2 (2009)*;

--$20,045,000 revenue bonds, series K-1 (2009)*; and

--$26,365,000 revenue bonds, series K-2 (2009)*.

*These bonds are variable rate demand obligations supported by bank letters of credit.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/site/re/750012

U.S. Nonprofit Hospitals and Health Systems Rating Criteria (pub. 09 Jun 2015)
https://www.fitchratings.com/site/re/866807

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https://www.fitchratings.com/regulatory

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Contacts

Fitch Ratings
Primary Analyst:
Paul Rizzo, +1-212-612-7875
Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst:
Tipper Austin, +1-212-908-9199
Associate Director
or
Committee Chairperson
Jim LeBuhn, +1-312-368-2059
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com